Is Intervention a Signal of Future Monetary Policy? Evidence from the Federal Funds Futures Market

Abstract

Sterilized foreign exchange market intervelltioll may affect the exchange rate if it signals future monetary policy actions. Sigllaling will be effective if the celltral bank backs up interventioll with predictable changes in the stance of molletary policy and, in turn, affects currellt expectations. We investigate whether illtervention operations in the United States are lelated to changes in expectatiolls over the stance of future monetary policy, whele expectations are proxied by ifederal funds futures rates. This relatively new futures market instrument has proved to be all efficiellt and ullbiased predictor of the future spot federal funds rate. Estimates obtained from a GARCH time-series model over the l 989-93 period using daily data do not suppol1 the signalillg hypothesis: dollar-suppolt intervention is not related to a rise in expected future short-term interest ates (monetary tightening). However, intervention appears to significantly increase the conditional variance of federal funds futures rates, suggesting that it adds considerable noise to the market alld possibly increasing the degree of uncertainty ovet the future course of molletary policy. THE EFFECT OF FOREIGN EXCHANGE MARKET INTERVENTION on exchange rates is a subject of continuing controversy. Few doubt that unsterilized intervention may affect nominal exchange rates by changing interest rates and monetary aggregates. However, the effect of sterilized intervention on exchange rates is less clear. The portfolio balance channel, through which sterilized intervention changes the currency denomination of relative asset supplies and thereby the exchange risk premium if assets are imperfect substitutes, has received little empirical support (for example, Rogoff 1984; Humpage 1991; Edison 1993; Sweelaey 1995,